Social Security Will Always Be Pay As You Go

I wrote about this once before, but I want to rehash it here again because I found a book that says the same thing I said. From Schweickart's"Economic Democracy:"

If we think in terms of material resources, it is clear that all social security systems are "pay as you go," because, however pensions and annuities are structured, the material fact is, people who are currently working must produce the goods and services consumed by those who no longer work. It is more honest — and ultimately fairer — for the older generation to acknowledge frankly their dependency on the younger generation than to pretend to be independent — just as that younger generation should acknowledge the fact that their current independence (such as it is) was made possible by an older generation that cared for them for the first two decades or so of their lives.

To be clear, "pay as you go" refers to a Social Security system in which the currently working are taxed and the revenue from that tax is sent out to the currently retired. This is meant to be contrasted with a savings-based Social Security system in which the income of the currently working is used to buy up assets, and then those assets are sold to generate income for them when they retire (how public or private this system is varies by proposal, but it doesn't matter here). These seem like two different approaches that are clearly distinguished from one another, but they really aren't.

If we ignore money and accounts, it is clear that it is impossible to implement a Social Security system that does not utilize a "pay as you go" scheme. Because retired people are not engaged in production, they necessarily live off of the production of those coming up behind them, i.e. the currently working. No amount of pre-saving can ever get around this brute fact.

In a savings-based system, the currently retired sell their accumulated assets to the currently working who of course pay for them from their current incomes. The currently retired then use the revenue from these asset sales to buy goods and services that the currently working produced. If you trace what has happened here closely, you see that the way this works is that a fraction of the currently working's income goes to the currently retired who then use it to buy goods and services.

In a "pay as you go" system, the currently working are taxed money from their current income that goes to the currently retired. The currently retired then use that money to buy goods and services that the currently working produced. Just like the savings-based system, what happens in this system is that a fraction of the currently working's income goes to the currently retired who then use it to buy goods and services.

The only difference between these two systems are their procedural details. In the savings-based system, the procedural mechanism that generates the desired generational transfer is the buying and selling of assets: you buy assets from the retired when you are working and sell assets to the working when you are retired. In the "pay as you go" system, the procedural mechanism that causes the generational transfer is taxing and transferring: you transfer to the retired when you are working and receive transfers from the working while you are retired. In both cases, income is going from currently working to currently retired.

Importantly, because these two mechanisms are fundamentally the same, shocks that cause problems for the "pay as you go" system also cause problems for the savings-based system.

For instance, much is made of the fact that the number of workers per retired persons is falling, and this is meant to show how "pay as you go" is problematic. But the savings-based system would have just as much of a problem with this kind of demographic shift. To the extent that a lower worker-to-retiree ratio means less overall production to go around, someone will have to take a hit no matter what. There is no way around it. When the retired go to disgorge all of those accumulated assets, that will not make more stuff magically appear. Something will have to adjust, whether higher savings rates or falling asset values or something else, in order to make everything balance out.

The upshot here is that most of the things you hear about the problems of the "pay as you go" approach are utterly confused and wrong. All retired people live off of the production of those coming up behind them, no matter what system you use. Relatedly, the retirement security of a generation always depends on the generations behind them, not what those older than them do (the old people can't "spend all the money" or other silly notions like that). There may be good reasons to use a savings-based approach, but most of the reasons usually given aren't those reasons.